Fed’s Balance-Sheet Unwind Puts Treasuries on ‘Uncertain’ Path

The Treasuries market is girding for potential disruptions from the next and trickiest stage of policy makers’ tightening campaign: the shrinking of an $8.5 trillion bond portfolio.

With the Federal Reserve releasing minutes from its latest meeting on Wednesday, traders are looking for further details on the plans to let billions of dollars worth of bonds to mature each month without replacing them.

Already roiled by the steepest trajectory of Federal Reserve interest-rate increases in decades, investors are now readying for what’s known as quantitative tightening, or QT. Fed Chair Jerome Powell himself cautioned earlier this month that the process -- seen as secondary to rate hikes -- has an element of uncertainty around it.

“It’s actually because QT is supposed to run in the background that makes it more dangerous,” said Priya Misra, global head of rates strategy at TD Securities. By sending inflation-adjusted yields higher, it will strengthen tightening in US financial conditions and slow the economy, she said.

Powell described QT as having an “important role” in firming monetary policy and said it will help return financial conditions to a “more neutral” calibration. Market participants have outlined multiple areas of possible stress as that happens. The following are among them:

Yield Impact

It may push up longer-term rates, as Misra outlines. Ten-year Treasury yields were around 2.72% Tuesday, up from 1.51% at the end of last year, and earlier this month reached as high as 3.20%, a level unseen since 2018.